Putin Promoting Sochi Tightens Grip as Investors Fret

Russian President Vladimir Putin, right, and Igor Sechin, CEO of Rosneft, the world's largest publicly traded oil producer, started working together at St. Petersburg city hall. Photographer: Alexei Nikolsky/ITAR-TASS via Landov

Jan. 30 (Bloomberg) -- When Igor Sechin was working as
President Vladimir Putin’s deputy chief of staff a decade ago,
visitors to his Kremlin office noticed an unusual collection on
the bookshelves: row after row of bound volumes containing
minutes of Communist Party congresses.

The record stretched across the history of the party and
its socialist predecessor -- from the first meeting in March
1898 to the last one in July 1990, a year and a half before the
Soviet Union collapsed, Bloomberg Markets will report in its
March issue.

Sechin regularly perused the documents and took notes, says
Dmitry Skarga, who at the time was chief executive officer of
Russia’s largest shipping company, OAO Sovcomflot.

“He was drinking from this fountain of sacred knowledge so
that Russia could restore its superpower status and take its
rightful place in the world,” Skarga says.

Sechin’s back-to-the-future fascination with his country’s
communist past is something he shares with Putin, who, soon
after coming to power in 1999, restored the music (though not
the lyrics) of the Soviet-era national anthem and later
described the collapse of the USSR as the greatest geopolitical
catastrophe of the 20th century.

Sechin himself is an open admirer of socialist icons such
as Cuba’s ailing Fidel Castro, the late anti-U.S. Venezuelan
leader Hugo Chavez and the executed Argentine Marxist Che
Guevara, says Victor Mashendzhinov, who studied with Sechin at
college. As a young man, Sechin served alongside Cuban fighters
in the Cold War hot spots of Angola and Mozambique.

State Control

Sechin, 53, has put his careful study of communist-era
documents into practice at state-run OAO Rosneft, the world’s
largest publicly traded oil company by output and reserves.
During a decade at Rosneft, Sechin has turned it into something
resembling in size the gargantuan Soviet Union ministry that was
once in charge of oil production, mainly by swallowing up
rivals.

Beginning in 2004, when Putin appointed him Rosneft’s
chairman, Sechin arranged Rosneft’s takeover of the main assets
of Mikhail Khodorkovsky’s Yukos Oil Co., according to
Khodorkovsky and former Yukos managers Bruce Misamore and
Alexander Temerko. Yukos was Russia’s largest crude producer at
the time. Last year, having become Rosneft’s CEO in May 2012, he
orchestrated the company’s $55 billion purchase of TNK-BP, a BP
Plc oil joint venture in Russia.

‘Firm’ Believer

Sechin is the leading exponent of Putin’s stated
determination to restore the state’s role in the Russian
economy. Putin used Rosneft, through its acquisitions, to return
Russian oil to state control. The company, 69.5 percent
government owned, controls about 40 percent of Russia’s crude
output.

In a similar vein, Putin re-established majority state
control of natural gas-exporting behemoth OAO Gazprom. The
company had been privatized in the mid-1990s under his
predecessor, Boris Yeltsin, cutting the government’s stake to 41
percent.

To develop high-technology industries such as armaments and
pharmaceuticals, Putin created Rostec, a state corporation that
encompasses 663 companies employing 900,000 people, or 1.2
percent of the entire Russian workforce. He expanded state-run
banks OAO Sberbank and VTB Group, whose dominance in retail
banking has edged out foreign rivals such as HSBC Holdings Plc
and Barclays Plc.

Sechin declined requests to be interviewed or to answer
written questions. In a telephone interview on Jan. 20, Putin
spokesman Dmitry Peskov said of Sechin: “Sechin is a believer
in the role of the state in his economic philosophy while at the
same time not excluding a free-market approach. And he is firm
in pursuing his viewpoint.”

Slowest Expansion

Of Putin’s relationship with Rosneft, Peskov says, “The
president can’t get involved in the affairs of a company.”

Even as Putin, 61, stages the world’s most expensive
Olympics, the $48 billion Winter Games in Sochi, to showcase the
glories of present-day Russia, he has spent his time in office
reshaping the economy to resemble the country’s Soviet past.

After Rosneft’s March 2013 acquisition of TNK-BP, state-owned enterprises accounted for more than 50 percent of Russia’s
gross domestic product, up from 30 percent in 1999, according to
data published by BNP Paribas SA’s Moscow unit and the European
Bank for Reconstruction and Development, or EBRD.

Russia’s economy grew 1.4 percent last year, Economy
Minister Alexei Ulyukayev said yesterday. That’s the slowest
expansion since the 2009 recession. The ministry projects growth
will average 2.5 percent a year through 2030, compared with an
annual 7 percent from 2000 to 2008.

Competitive Realities

“Under Putin’s rule in Russia, the state is monopolizing
key branches of the economy,” says Anders Aslund, a senior
fellow at the Washington-based Peterson Institute for
International Economics. Aslund was an economic adviser to
Yeltsin in the 1990s, when the government carried out a wave of
selloffs of state assets that put 70 percent of the economy in
private hands.

“Incredibly, Putin seems oblivious both to the collapse of
the Soviet Union’s economic system and why it happened,” Aslund
says. “Half of the economy is controlled by state companies,
and that is why the Russian economy isn’t growing.”

Such criticism ignores competitive realities, Peskov says.

“For example, in shipbuilding it’s absolutely pointless to
carry out privatization,” he says. “You can privatize
enterprises, but they won’t be competitive; they will be doomed
to failure. So consolidating the assets under the state’s wing
is the only way to preserve key sectors of the economy.”

Widespread Malaise

The slowdown in Russia coincides with widespread malaise in
some of the larger emerging markets -- including Brazil and
India, which along with Russia and China make up the BRIC
countries, as they are known.

Russia is No. 14 in Bloomberg Markets’ annual ranking of
emerging-markets countries. Its growth has decelerated or
remained unchanged every quarter since Putin won a new term as
president in March 2012.

Putin has said Russia stacks up favorably with many
European countries on some key economic indicators. For example,
Russia’s unemployment rate for November was 5.4 percent compared
with 11.1 percent in the euro zone.

“The economy is in much better shape than in a number of
European countries,” Peskov says. “That is why we don’t take
this criticism seriously.”

State Capitalism

In furthering Putin’s mission, Sechin is more than just a
loyal underling to the president, says Khodorkovsky, who accuses
Sechin of orchestrating the destruction of Yukos. In December,
Putin showed he’s confident enough in the economic change he’s
wrought to free Khodorkovsky, once Russia’s richest man and
Putin’s most powerful rival.

Khodorkovsky, who was imprisoned in 2003 on tax evasion and
fraud charges and spent 10 years in prison camps, says Sechin
tried to block his release.

“I don’t have any such information,” Peskov says. “I
doubt it.”

Khodorkovsky also says Sechin has helped to shape as well
as execute Putin’s economic policies.

“Sechin is a real oligarch, in the classic meaning of this
word,” Khodorkovsky told Bloomberg News in an interview in
Berlin on his fourth day of freedom. “He convinced Putin that
state capitalism is right and is realizing this idea in
practice.”

Strategic Industries

Putin, a one-time KGB colonel, maintains his tight grip on
the economy by drawing on Sechin and other members of his inner
circle to ensure that loyal allies direct the country’s
industrial strongholds and revenue flows. Sechin, like Putin, is
a St. Petersburg native and worked for Putin in the 1990s when
the Russian leader was deputy mayor there.

Like Sechin, Putin’s favored few are men who were
associated with him before he became president. They include the
CEOs of Gazprom, Sberbank, Rostec and monopoly rail operator OAO
Russian Railways. Gazprom, Rosneft and Sberbank are now the
country’s three largest companies by market capitalization.

Putin, Sechin and other senior figures want to ensure that
big companies central to the economy are in state hands, says
Chris Weafer, a senior partner at Moscow-based consulting firm
Macro Advisory.

“They hanker after what they recall as the stability of
the Soviet system, and part of that is keeping control of so-called strategic industries,” he says.

‘Necessary Role’

“Sechin is easily the most influential person in the
country after Putin,” says Sergei Markov, a political analyst
and vice rector of the Plekhanov Russian University of Economics
in Moscow. “Putin trusts him more than anyone else.”

Having Sechin in control at Rosneft reflects Putin’s
commitment to large government-run corporations.

“The experience of successful economic modernization of
countries such as South Korea and China shows that the state has
a necessary role to play,” Putin said in a 2012 campaign
manifesto. “Large private capital willingly doesn’t want to go
into new areas because it doesn’t want to carry major risks.”

Lately, that private capital has been flowing away from
Russia. Concerns about Putin’s treatment of Khodorkovsky and
what it said about doing business in Russia encouraged investors
to pull $420.6 billion out of the country since 2008 to the end
of last year, according to the central bank -- a trend the
government has said it wants to reverse.

Sochi Olympics

Khodorkovsky’s release from prison won’t be enough to allay
the concerns of foreign investors, said Alexander Kliment and
Yael Levine of Eurasia Group, a political-risk research firm, in
an e-mailed commentary on Dec. 19. His release, they say, was a
public relations stunt ahead of the Sochi Olympics and doesn’t
mean the business climate will improve.

The key drag on the economy is corruption, much of it
concentrated in the state sector, says Elena Panfilova, head of
Berlin-based Transparency International’s Russia branch. Russia
was ranked the most corrupt nation among the Group of 20
advanced economies in the organization’s 2013 Corruption
Perceptions Index.

Another hindrance is the fact that state-run companies face
no incentive to cut costs and eliminate waste because nonstate
shareholders are in a minority, says Mattias Westman, CEO of
London-based Prosperity Capital Management, the largest Russia-focused equity investor, which manages about $4 billion in
Russia and other former Soviet countries.

Stifling Enterprise

Jim O’Neill, the former Goldman Sachs Asset Management
chairman who coined the term BRIC in 2001, says Putin’s stifling
of private enterprise has led to Russia’s growth slowdown.

“Unless they do undertake reform, that’s the future,”
O’Neill says.

Kingsmill Bond, chief strategist at Sberbank CIB, an
investment arm of Russia’s biggest lender, says some investors
and commentators hold Russia and China to different standards on
transparency and human rights issues. With Russia trailing
behind China’s 7.7 percent growth in 2013, Bond says, “it would
be fair to say that Russian capitalism is judged more
assiduously than that in China.”

Largely thanks to Rosneft and Gazprom, Russia (population:
143 million) is the world’s largest energy exporter by barrels
of oil equivalent a day and the biggest crude producer after
Saudi Arabia. The government receives about half of its budget
revenue from oil and gas exports.

Perilously Dependent

The EBRD said in December 2012 that Russia was becoming
perilously dependent on commodities and failing to prepare for
falling oil output in 20 years. Lev Snykov, a partner at
Greenwich Capital in Moscow, says the price needs to be at $120
a barrel or higher for the government to be able to balance the
budget. The price of Brent crude was $107.23 on Jan. 29.

When Sechin became CEO of Rosneft, he had already been
deeply involved in the company. As chairman beginning in 2004,
he had a decisive say in strategic decisions because of his
unrivaled access to the president, according to Vladimir Milov,
who was deputy energy minister in 2002.

As a boss, Sechin displayed a ruthless streak, Milov says.
In 2010, he initiated the sacking of CEO Sergei Bogdanchikov, a
lifelong oilman who had kept Rosneft afloat through the volatile
economic times of the late 1990s, Milov says.

He says Bogdanchikov had his own relationship with Putin,
though not as close as Sechin’s. The pair wrestled over
operational control, and Sechin eventually forced Bogdanchikov’s
exit, Milov says.

‘Simply Amazing’

While serving as Rosneft chairman, Sechin was also
appointed deputy prime minister with responsibility for the
energy sector in 2008. He held the Rosneft position until 2011,
when government officials with a potential conflict of interest
were required to quit board seats at state-run companies.

He was the most effective bureaucrat in the government,
says former Central Bank First Deputy Chairman Sergei
Aleksashenko.

“From the point of view of bureaucratic management, he was
simply amazing,” says Aleksashenko, director of macroeconomic
research at the Higher School of Economics in Moscow. “He
worked like a machine.”

Under Sechin, Rosneft has grown into a leviathan. From 2010
through 2013, its annual revenue increased 128 percent to an
estimated $143.6 billion, according to a forecast by 13 analysts
surveyed by Bloomberg.

Big Oil

Its oil and gas output of 4.88 million barrels a day as of
the end of the third quarter of 2013 was greater than Exxon
Mobil Corp.’s 4.02 million and PetroChina Co.’s 3.8 million; its
proven oil and gas reserves, including TNK-BP, rose to 29.6
billion barrels at the end of 2012, above Exxon’s (25 billion)
and PetroChina’s (23 billion).

The company posted an eightfold rise in third-quarter
profit in 2013, after recording a 167 billion ruble ($4.98
billion) gain on the value of TNK-BP. Sechin clinched his latest
deal on Dec. 20 -- the day of Khodorkovsky’s release -- with the
acquisition of Morgan Stanley’s global oil-trading and transport
business for an undisclosed sum.

Sechin has also presided over a $270 billion supply deal
signed in June that will make China Russia’s largest crude
customer during the coming decade.

Compared with non-state-owned energy giants such as Exxon,
Rosneft is inefficient. Even though Rosneft’s lifting costs --
the cost of getting oil out of the ground -- are less than a
third of Exxon’s, the Russian company’s workforce is less
productive.

“The main reason to hold Rosneft is the reserves,”
Greenwich Capital’s Snykov says.

Sechin had no hands-on oil experience before joining
Rosneft as a manager. Initially, operational control was left to
Bogdanchikov. Still, Sechin’s resume as a state bureaucrat
served him well, with his rise neatly trailing his boss’s.

Born in what was then called Leningrad, he attended a
school specializing in French. His parents, who both worked at a
metallurgical plant, were divorced when Igor and his sister
Irina were young.

After finishing secondary school in 1977, Sechin studied
Portuguese at Leningrad State University. Unlike children of
well-connected parents, Sechin was admitted on his own merits,
says fellow student Mashendzhinov, who is now CEO of First Media
Co., a St. Petersburg-based advertising firm.

Rock Concerts

Sechin pored over Marxist-Leninist texts and could cite
from memory biographical details of Communist leaders through
the decades, recalls Larisa Volodimerova, another fellow
student. He wasn’t one to frequent underground rock concerts
frowned upon by the authorities, says Volodimerova, now a human
rights activist who lives in Amsterdam.

After graduating in 1984 with a Ph.D. in economics and
being fluent in Portuguese and French, Sechin joined the Soviet
Army and served as a translator in Portuguese-speaking
Mozambique and Angola, where Soviet- and U.S.-backed factions
competed for dominance during the final decades of the Cold War.

“A trip to a hot spot was seen as a good career move
then,” Mashendzhinov says.

In Angola, where Soviet officers served as advisers to
Angolan insurgents and Cubans fighting at their side, Sechin’s
friendships led to an affinity with Castro’s island bastion of
communism.

Downed Cuban

One day, Sechin witnessed at close hand the death of a
Cuban pilot whose plane was shot down by Angolan rebels,
according to Anatoly Kolomnin, the deputy head of the Moscow-based Union of Veterans of Angola.

In Cuba about three years ago, Sechin sought out the
pilot’s widow and son, says Kolomnin. He brought the son to
Russia for his university studies, Kolomnin says.

What turned out to be Sechin’s best career move of all came
in 1988, when he went to work at St. Petersburg’s city hall,
where he became acquainted with Putin.

In 1994, when filmmaker Igor Shadkhan came to interview
Putin, then a newly appointed deputy mayor, he was surprised to
see Sechin in the reception area of Putin’s office. Shadkhan
says Sechin was the only male secretary in sight, recording the
names and details of all visitors in a thick, black notebook.

“Putin chose Sechin because he wasn’t talkative and can be
trusted with any information,” Shadkhan says.

Confounding Rivals

When Putin went to Moscow in 1996 to work as a senior
Kremlin official under Yeltsin, Sechin followed as a lower-ranking bureaucrat in the presidential administration. When
Putin became president in 2000, Sechin spent eight years as his
deputy chief of staff.

Constitutionally barred from serving more than two
consecutive terms as president, Putin bided his time for four
years as prime minister and installed Sechin as deputy prime
minister while Dmitry Medvedev sat in as head of state. When
Putin reclaimed the presidency in 2012, he appointed Sechin as
CEO of Rosneft.

Ex-Sovcomflot boss Skarga says that even after 2000, no one
took Sechin seriously, seeing him merely as Putin’s loyal
sidekick. Yet within a few years, according to Khodorkovsky,
Sechin confounded his rivals by masterminding the 2003-2004
attack on Yukos.

Corporate Jet

After Khodorkovsky was arrested by armed police at gunpoint
in a corporate jet in Siberia in October 2003, Yukos was
eventually driven to bankruptcy, owing the government $26.6
billion, according to Claire Davidson, a spokeswoman for the
former management.

The Kremlin wanted to imprison Yukos executives so that
they couldn’t prevent the takeover, says Temerko, who now runs a
London-based business that manufactures North Sea oil and gas
platforms.

“Sechin was the main ideologue and driver behind the Yukos
case,” Temerko says. “He was intimately involved in the
process from start to finish.”

Peskov says there’s no truth to these allegations.

The government subsequently dismantled Yukos. Most of the
company’s assets eventually ended up in Rosneft’s possession.
That was always Putin’s endgame, says Misamore, who as a former
director of Yukos helps run two Dutch foundations that hold
Yukos’s overseas assets.

“His philosophy was, private ownership of the commanding
heights of the economy is not acceptable,” Misamore says. “He
wanted to take it back to the Soviet Union.”

Western Technology

In acquiring first Yukos and then TNK-BP from BP and its
billionaire partners in March 2013, Rosneft gained control of
companies that had pioneered the use of Western technology and
management in Russia.

Yukos hired foreign executives such as Misamore, who made
it the first Russian company to switch to quarterly financial
reporting under U.S. accounting standards. Yukos also introduced
new drilling techniques to bolster crude output, which had been
in decline during most of the 1990s.

BP set up TNK-BP in 2003 with Putin’s blessing. While the
new company paid $19 billion in dividends to BP from its
inception, according to BP’s 2012 annual report, infighting
between the Russian and U.K. partners eventually led to last
year’s takeover.

Increased Production

Under that deal, BP has a 19.75 percent stake in Rosneft
and BP CEO Bob Dudley occupies one of two seats BP will
eventually be entitled to on Rosneft’s nine-person board of
directors. Former Exxon Senior Vice President Donald Humphreys
and former Morgan Stanley CEO John Mack are among the four
independent board members.

TNK-BP increased production by more than 40 percent during
the nine years before Rosneft bought it.

“The concern is, will Rosneft be able to achieve that same
level of operating efficiency as TNK-BP did before it was
acquired?” says Rob West, an oil analyst at Sanford C.
Bernstein & Co. in London. “That really is the big question.”

Rosneft managed to increase crude production by an annual
average of more than 3.5 percent from 2009 to 2012. While that
looks faster than TNK-BP’s annual 1.5 percent rise over the
period, West says that’s largely because strong government ties
have given it access to new resources such as the Vankor field
in Siberia -- the biggest oil find in Russia in 25 years --
which started pumping oil in 2009 and now accounts for almost 10
percent of Rosneft’s production.

Huge Debts

Rosneft is also shouldering huge debts, says Tatiana
Mitrova, head of the oil and gas department at the Energy
Research Institute of the Russian Academy of Sciences. Following
the TNK-BP deal, the company’s indebtedness more than doubled,
to $72 billion.

To ease financial pressures, Rosneft has drawn down the
first tranche of up to $70 billion in advance payments from
China National Petroleum Corp. in exchange for supplies,
according to a Jan. 15 Rosneft statement.

In October, Rosneft separately signed a provisional $85
billion agreement to supply China Petrochemical Corp. with 100
million metric tons of crude over 10 years. While any advance
payments from that deal could provide a cash lifeline, the
agreement may also restrict Rosneft’s ability to supply other
customers at potentially higher prices, West says.

Soft Spot

Rosneft, together with other Russian oil producers, is
investing $13 billion in Venezuela in partnership with state-owned monopoly Petroleos de Venezuela SA. Rosneft was not put
off by PDVSA’s questionable performance. Even as proven reserves
almost quadrupled from 1999, when Chavez became president, to
2012, the country’s crude output declined about 13 percent to
2.7 million barrels a day, according to the BP Statistical
Review of World Energy 2013.

Sechin has demonstrated a soft spot for Venezuela and for
Chavez, who died last March. Sechin, who sported a Chavez-emblazoned T-shirt during a trip to Venezuela in 2012 and headed
the Russian delegation to the leader’s funeral, said last year
that the country is “our No. 1 priority.”

At a ceremony to mark the naming of a Moscow street in
Chavez’s memory, Sechin read from the patriotic poetry of
Vladimir Mayakovsky, a Soviet revolutionary poet.

‘Go-To Man’

“Chavez always told us that if you need to sort out an
issue with Russia, you go to Sechin,” Diosdado Cabello,
president of the National Assembly, told reporters before
meeting Sechin in Moscow last October. “He’s the go-to man.”

Sechin is the go-to man at home as well, says Sovcomflot’s
ex-head Skarga.

Unlike those Russians who accumulated vast wealth during
the privatization of state industries, Sechin isn’t preoccupied
with money, says Skarga.

“He doesn’t have any billions,” he says.

What Sechin does have, Skarga says, is power. He will have
it as long as Putin does, says Masha Lipman, an analyst at the
Carnegie Moscow Center.

Putin has been in power for 14 years. Under a 2008
amendment to the constitution that allows presidents to serve
two consecutive six-year terms, Putin could remain as president
until 2024, when he would be 72 years old.

‘Psychological Milestone’

Though politically stricken by economic stagnation, Putin
is likely to stand for re-election in 2018, says Andrew
Monaghan, a senior research fellow at Chatham House, a London-based research center.

“Putin’s leadership currently looks steady and sturdy
enough to last until the next election,” he says.

Sechin looks well set, too. He now has his eyes on a post-communist breakthrough: In a Jan. 9 research note, Sberbank said
Russian oil output will probably approach the Soviet-era peak of
11.4 million barrels a day by 2016 or 2017.

“It would be a very big psychological milestone for Russia
to get back to the Soviet-era peak production,” says Julian
Lee, a senior analyst at the London-based Centre for Global
Energy Studies.

It would be a boost, too, for the former city hall
secretary whose study of the Soviet communist past has
positioned him to play a leading role in shaping Russia’s
economic future.